Debt & Equity

Five Years After Market's Peak, Defensive Refis Grow

Nearly five years ago, the commercial mortgage-backed securities (CMBS) industry was booming and on the cusp of a peak year.

In 2007, nearly $230 billion in CMBS was issued as the commercial real estate markets soared. But the day of reckoning is expected to come next year, when a slew of five-year balloon loans made at the height of the market will soon start coming due.

And after next year, longer-term 2007-vintage CMBS loans are set to mature, leaving many owners to restructure, recapitalize, and plug some gaps in the capital stack. A huge increase in demand for structured-finance products like bridge, mezzanine, and preferred equity is expected over the next few years.

“We’ve all seen the charts regarding maturities scheduled between now and 2017—it’s like a hockey stick,” says Kevin Smith, who leads the Alternative Capital Division of New York–based Centerline. “There’s going to be a huge need for bridge capital and preferred equity or mezz where the deals can support it.”

Mezzanine debt is generally pricing from 10 percent to 14 percent for multifamily deals. And preferred-equity providers are generally asking for mid- to high-teens returns all-in. The bridge-loan market has improved, with rates around 300 to 500 basis points over LIBOR.

The question is, will there be enough capital available on the market to make all of those deals whole again?

The 2007 vintage of CMBS loans was the sourest by far in terms of underwriting standards, and about $15.5 billion of those will mature next year, according to CMBS monitoring agency Trepp. About 27 percent of the five-year CMBS loans issued in 2007 are already in special servicing, and Trepp expects that the majority of what remains will also wind up in special servicing eventually.

It's not exactly a new trend—2006 was no beauty either. This year, about $13.7 billion in 2006-vintage five-year CMBS loans matured, and only about 29 percent of them were retired, meaning there’s still $9.9 billion remaining, the majority of which is in special servicing. Overall, the multifamily industry still has the highest CMBS delinquency rate among all asset classes, at 16.18 percent at the end of November, according to Trepp.

Following the Market Down But this problem isn’t limited to just the CMBS industry. Banks, private funds, and the government-sponsored enterprises (GSEs) were forced to compete with the CMBS industry during the boom, and many of those aggressive loans will also join the defensive refinancing parade.

“NOIs are off from peak, appraisers are gun-shy and coming in below value, and lenders are all doing trailing analysis and utilizing either exit tests or debt yield tests—all of which result in lower proceeds,” says David Valger, founder of New York–based preferred-equity provider DVO Real Estate Holdings. “In my estimation, roughly half of all the debt that will need to be refinanced in the immediate and intermediate future won’t be able to get the same level of debt it had in the first place.”

Many banks engaged in an “extend and pretend” strategy throughout the downturn and found that discounted payoffs often led to the best recovery. This has given many private funds offering first mortgages—priced well above what the GSEs offer—an opportunity to place some debt in the multifamily industry.

“If you’re the bank, the buyer that’s most likely to pay the most for that note is the existing borrower, since they have a vested interest and know the asset well,” says Ryan Krauch, principal at Los Angeles–based first mortgage lender Mesa West Capital. “A group like ours will come in and restructure and help rebuild the capital stack. We’re seeing more and more recapitalizations or restructurings, and I think that will continue.”

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About the Author

Jerry Ascierto is Editor-in-Chief of the Residential Construction Group at Hanley Wood. Based in the New York City area, Jerry has been covering the multifamily and single-family industries since 2006. He can be reached at jascierto@hanleywood.com.